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INSIGHT: Loans from family, friends are risky business |
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By SCORE For the Sioux Falls Business Journal
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Tuesday, 24 April 2007 |
For many small businesses, bank loans, venture capital and money from angel investors are financing long shots at best. It is far more common for a small business to secure funds from family members or even friends.
In fact, more businesses are started with loans from friends and family than from any other single source. The money comes from aunts and uncles, brothers and sisters, moms and dads, grandparents, in-laws, roommates, mentors, personal lawyers and many others.
Availability is the big draw. The downside is that business loans from family and friends also can be a disaster if they are not done right.
Unstructured or loosely structured financing and payback terms can haunt both sides later on. Research shows that 14 percent of business loans from family and friends go into default, compared to about 1 percent for bank loans.
To increase the odds of success, approach family and friends with a detailed loan proposal, including financials from your business, just as you would a bank or venture capitalist. Be frank about the risks. If things go badly, they could lose all or some of their money. Consider the consequences of a soured business deal to your relationships.
Pick a financing structure that works best for your business and make certain everyone understands it. Specifically, be clear on whether the deal involves an ownership stake in your business or whether it is a simple debt you plan to repay. And be clear about repayment terms.
To legally seal the deal, use a promissory note. Putting the terms of your borrowing agreement into proper legal form is crucial. You can find the downloadable legal documents you need, including many different promissory note variations, at www.findforms.com. Self-help legal publisher Nolo also offers loan forms and related information at www.nolo.com.
Another helpful resource is Circle- Lending, a company that provides loan administration, recordkeeping, payment processing and structural support for these types of loans.
CircleLending takes verbal deals and turns them into legitimate business transactions. Check the small business section at www.circlelending.com for information. |